All of the following are benefits of an installment sale to a grantor trust except:
A. The property sold to the trust is removed from the grantor’s estate.
B. By selling property to the trust in exchange for a note, the grantor “freezes” the value of the property in his estate.
C. Any income and appreciation generated by the property after the sale belongs to the trust.
D. If the grantor dies while the note is outstanding, the property sold and any increases in its value are pulled back into the grantors estate.
The correct answer and explanation is:
Correct Answer: D. If the grantor dies while the note is outstanding, the property sold and any increases in its value are pulled back into the grantor’s estate.
An installment sale to a grantor trust is an estate planning strategy that offers several tax and wealth transfer benefits. A grantor trust is a trust in which the grantor retains certain powers or interests, making the trust disregarded for income tax purposes. This allows the grantor to sell assets to the trust without triggering immediate income tax consequences. Importantly, the trust and the grantor are treated as the same taxpayer for income tax purposes, so the sale does not result in recognized gain, and no capital gains tax is triggered at the time of sale.
Option A is correct because the property is removed from the grantor’s estate, assuming the trust is properly structured and the transaction is respected by the IRS. This means that any future appreciation of the property will not be subject to estate tax upon the grantor’s death.
Option B is also correct because when the grantor receives a promissory note in exchange for the property, the value of the note remains fixed. This effectively “freezes” the value of the grantor’s estate at the value of the note, allowing any growth on the asset to benefit the trust and its beneficiaries.
Option C is accurate because all post-sale income and appreciation on the asset belong to the trust. This allows the trust assets to grow outside of the grantor’s estate, increasing the wealth passed on to beneficiaries.
Option D is incorrect and is not a benefit. If the grantor dies while the note is still outstanding, there is a risk that the IRS may argue that the full value of the property, including any appreciation, should be included in the grantor’s estate. This outcome would undermine the estate planning benefits of the strategy.